August 10, 2015 / 11:43 PM / 4 years ago

Buffett bets Precision can deliver long-term as aircraft sales grow

HOUSTON (Reuters) - Warren Buffett’s $32.3 billion deal for Precision Castparts Corp PCP.N shows his willingness to overlook repeated operational stumbles at the company to place a long-term bet on the growth of global air travel.

Buffett usually seeks out companies with strong leadership and earnings metrics. But Precision, a maker of aerospace and other parts, has posted lackluster results for the past year, most recently in late July when it reported an 18 percent decline in net income for its fiscal first quarter. The company blamed higher-than-expected costs to ramp up to meet demand from aircraft makers.  

Shares in the company were down nearly 20 percent this year until the Berkshire bid became public, and the company had a forward price-to-earnings ratio of 14.44, according to Thomson Reuters data, its lowest P/E ratio since July 2010.

Precision’s sales to the oil and power sector - while less than a fifth of overall revenues - have also suffered in the past year amid the more than 60 percent drop in oil prices CLc1. That has put pressure on Chief Executive Mark Donegan, who has held the role for 13 years, to improve results in the company’s core aircraft segment.

Buffett seemed unperturbed by that recent history when talking about the deal on cable news channel CNBC.

“I was very impressed by Mark, and of course I was impressed by the company,” Buffett said of meeting Donegan at Berkshire about five weeks ago. Berkshire had held a 3 percent stake in Precision.

Soon after that meeting, Buffett asked one of his investment managers, Todd Combs, to contact Precision about a bid. “They didn’t indicate they were particularly receptive, but they also indicated that they would listen,” Buffett said. [ID: nL3N10L3ST]

Berkshire’s acquisition price of $235 a share represents a 21.2 percent premium over Precision’s closing price on Friday.

Demand for new civilian aircraft is forecast to grow over the next several years. Boeing Co (BA.N) in June forecast that 160 million more people would travel by air this year, indicating a need for 900 new aircraft. Boeing (BA.N) and its main rival, Airbus (AIR.PA), say they expect to deliver more than 1,300 new aircraft this year. Both companies are pushing suppliers to support significant increases in the production rates for their most popular planes.

Roughly 70 percent of Precision’s revenues in its last fiscal year came from selling blades used inside aircraft engines, bolts and other fasteners that help bind fuselages, and dozens of other products crucial to an airplane’s construction and maintenance. Boeing’s 787 Dreamliner aircraft relies heavily on Precision’s products and technology, as do jet engines built by General Electric Co (GE.N) and Rolls-Royce (RR.L).    

Most of Precision’s sales are to customers in the United States, continuing a theme Buffett has outlined in the past that American industry is still worth the investment.    

“There is no obvious synergy with the rest of the Berkshire Hathaway portfolio,” Deutsche Bank analyst Miles Walton said. “This looks like a deal driven by the firm’s thinking that they are getting a large manufacturing firm in the aerospace industry well off its highs.”

One of Precision’s top 10 investors, who spoke on condition of anonymity, shares the view that the company’s business is only “momentarily depressed” given the ramp-up of production in the global airline industry.

“We think that in 18 months the company would have been worth $400 per share,” the investor said, citing a price 70 percent above Berkshire’s acquisition cost.

“It’s a classic example of Berkshire buying a depressed asset at a great price,” the investor said. “The shareholders get cashed out, so they don’t get to participate in the upside.”

Reporting by Ernest Scheyder in Houston; Additional reporting by Jonathan Stempel and Greg Roumeliotis in New York and Sweta Singh and Sagarika Jaisinghani in Bangalore; Editing by Joe White and Leslie Adler

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